A common refrain in Washington these days is that the Federal Housing Administration plays an outsize role in the mortgage market and should return to its traditional market share of 10% to 15%. That view would make more sense if the purchase mortgage market were operating anywhere near levels in place prior to the housing bubble.
Of course, that is the catch about today’s housing market. Even though there has been a steady stream of encouraging housing data as the latest S&P/Case-Shiller report demonstrates, the purchase mortgage market is still depressed by any measure.
There were only 2.4 million purchase loans originated in 2011, according to Home Mortgage Disclosure Act data. Furthermore, it appears there was little improvement in 2012. "The purchase market is at the lowest levels since the 1990s," Federal Reserve Gov. Elizabeth Duke said in a recent speech. She could have added that purchase mortgage activity is almost 50% below 2000 levels and still 23% below purchase activity at the height of the crisis in 2008.
To make matters worse, younger, lower-income and minority homebuyers are being particularly hard-hit by the weak purchase market. According to Gov. Duke, "from late 2009 to 2011, the fraction of individuals under 40 years of age getting a mortgage for the first time was half of what it was in the early 2000s." She added that since 2007, there has been "a fall of about 90% [in purchase originations] for borrowers with credit scores between 620 and 680." The HMDA data also indicates that lower-income and minority homebuyers saw the steepest declines in homeownership activity.
Why should the FHA take further steps to reduce its already diminished volume to bring its market share in line with a depressed purchase mortgage market?
FHA purchase activity has declined 34% since fiscal 2010 and is now 13% lower than even the pre-bubble level of 2000. In today’s mortgage market, a 10% to 15% market share would translate into lowering FHA purchase activity to 240,000 to 360,000 mortgages or less than 50% of current volume.
There is also no guarantee that further efforts by the government will work since they haven’t worked so far. The data shows that more restrictions on the FHA would only reduce homeownership opportunities for those prospective homebuyers who currently have no other option to finance a purchase.
For the wealthy, things could not be better. They have been able to take advantage of the low home prices and the even lower interest rates. Not surprising, all-cash sales are also at record levels. They made up about 30% of all purchases in 2012 according to the National Association of Realtors. DataQuick, a mortgage and real estate information firm, found that 32% of all purchase transactions in California were all-cash in 2012. These homebuyers did not need or want a mortgage. In other words, the private sector has returned to the housing market, just not to the mortgage market.
The problems for the private mortgage market are far more complicated than competition from the FHA. The private sector learned a very expensive and painful lesson from investing so heavily in subprime and alternative-A mortgages that led to the housing crisis.
We are already getting a glimpse today of how a private mortgage market would function even though the government is backing about 90% of all mortgages. Average credit scores for FHA and for the government-sponsored enterprises Fannie Mae and Freddie Mac have skyrocketed in the aftermath of the housing crisis as mortgage lenders have adapted to the new enforcement environment by adding credit restrictions (called overlays) to government underwriting requirements.
The crux of his incorrect argument is this: "Once the purchase market is functioning properly and creditworthy younger, lower-income and minority homebuyers are once again able to share in the opportunities in today's housing market, we can then examine the market share issue." This is just like George W. Bush saying he had to abandon free-market principles in order to save the free market.
The only real effect of government subsidized mortgages is to pump up the bubble of real estate prices. If the market were allowed to function normally right now, prices would decline to a level where "creditworthy young, low-income, and minority borrowers" would easily qualify for mortgages on ordinary commercial terms. This is what happened in the early 1980s, when the housing bubble that had grown during the inflation of the 1970s was allowed to pop, and millions of Americans were able to buy their first homes. Mr. Chappelle's dire prediction of a housing market reserved for the wealthy has already been disproved by history.